Recession mode

It is becoming increasingly apparent that Israel is entering an economic recession. Therefore, it should come as no surprise that senior officials from the Finance Ministry, the Prime Minister’s Office and the Bank of Israel have called an emergency meeting slated for next week to discuss the deteriorating situation.

Let’s hope that our economic leaders will wake up to the somber reality of a major slowdown and take the necessary steps, one of which is to take Bank of Israel Gov. Stanley Fischer’s advice and backtrack on the recent cabinet decision to expand the budget deficit target for 2013 from 1.5 percent of GDP, or NIS 14.5 billion, to 3% of GDP. At the very least, the government should heed Fischer’s warning, made publicly last month at the Israel Democracy Institute’s Caesarea Conference, and refrain from raising the deficit beyond 2.5% of GDP.

A slew of recent macroeconomic data show that we are in an economic slowdown. Deflationists have pointed to June’s cost of living index – down 0.3% against analysts’ forecasts for a slight rise – and warned of an imminent state of deflation. Consumer price decreases are often a symptom of a recession or at least a slowdown. Idle workers are willing to accept lower wages and businesses stuck with growing inventories or facing a sharp drop in demand are willing to sell products and services at lower prices.

In contrast, inflationists are warning that the slowdown might cause a sharp rise in prices soon as the central bank makes more money available to encourage growth. Either way, the situation is not good.

More worrying, as pointed out by Jerusalem Post columnist Pinchas Landau, is the ongoing decline in our trade balance. According to data released earlier this month, in June the trade deficit (adjusted for seasonal influences and not including ships or diamonds) was $1.85b., the largest since January. Looking at the entire first half on 2012, it turns out that exports as a proportion of imports have dropped to just 67.5%, from 76% in the same period last year and 83% in the first half of 2010. And weaker exports are plaguing all economic sectors, from hi-tech to low-tech to traditional industry. Hitech, which at one point accounted for more than half of export revenues, now makes up 46%.

The fall in exports is a direct result of the economic crisis in Europe, the stagnation of the US economy and the decrease in growth rates in China and elsewhere in the Far East. And this sorry state of affairs abroad will shortly lead to rising unemployment and either deflation or inflation locally.

On the backdrop of these data and others, the Central Bureau of Statistics downgraded its GDP growth estimate for the first quarter of 2012 to 2.7% from 3%, and even this might be overly optimistic.

It is absolutely imperative that Prime Minister Binyamin Netanyahu and Finance Minister Yuval Steinitz take a serious reassessment of the gloomy economic situation both abroad and locally and commit themselves to fiscal discipline. Unfortunately, both men give the impression that they have not fully internalized the potential risks. Despite warnings from Fischer, Netanyahu and Steinitz are going ahead with raising the budget deficit goal to 3% of GDP. If GDP growth for 2013 should fall below current forecasts – hardly an unlikely possibility – the real budget deficit could far exceed 3%.

A lack of fiscal discipline – an unprecedented hike in the defense budget, a costly public sector wage agreement – has already resulted in a sharp rise in the budget deficit for 2012, from 2% to 4%.

The prime minister and the finance minister must resist populist pressure and election year considerations and reign in government expenditures. In parallel, steps must be taken to reduce the increasing gap between the rich and poor by adopting a more progressive tax system.

Israelis in the top percentiles who benefited disproportionately from the past few years of economic growth should pay more taxes. Corporate tax should be raised and tax exemptions given to businessmen worth tens of billions of shekels a year should be done away with.

When high-ranking officials from the Finance Ministry, Prime Minister’s Office and Bank of Israel meet next week, they should face the prospect of an imminent economic recession with eyes wide open and take the necessary steps now to prevent a meltdown.